How to Use Dividends for Retirement Income

Dividends can be a good source of income for your retirement. If you reinvest your dividends, you can build up a solid portfolio of dividend-paying stocks. Reinvesting your dividends means you use them to buy more shares in the companies that are paying the dividends.

Once you retire, you can take the dividend payments to cover at least part of your living expenses. You'll still own the stocks, which may keep paying dividends for the rest of your life. You can have the payments mailed to you in the form of checks, or you can set up direct deposits into your bank account.

Dividends' Contribution to Total Return

In recent times, dividends have made up a large percentage of stocks' total return to investors. For instance, in the 1970s, dividend payments resulted in a 4.2% return on stocks. At the same time, price appreciation produced only a 1.6% return. In the 2000s, dividends returned 1.8%; the price of stocks dropped 2.7%.

The exceptions to dividends' strong contributions to overall return have been periods with long bull markets. In the 1980s, stocks returned 12.6% from price appreciation and only 4.2% from dividends. In the 1990s, the figures were 15.3% and 2.4%, respectively.

What Is Dividend Yield?

The dividend yield is the ratio of a company's annual dividend to its stock price at any time. It is shown as a percentage. For example, let's say a stock is trading at $64. It pays a dividend of 60 cents per quarter. That means its dividend yield is 3.75%.

To find this, you must first multiply the quarterly dividend ($0.60) by four. This is how you get the annual dividend of $2.40. You would then divide $2.40 by $64 to get 0.0375. Multiply that number by 100 to arrive at 3.75%.

One investment strategy is to invest in stocks with the highest current dividend yields. You can also invest in a fund that has the same goal. As with individual stocks, you can reinvest the dividends paid by the stocks held by the fund into more shares of the fund, or you can take cash payments.

But keep in mind that even firms with long histories of paying large dividends each quarter can cut their payments with no warning. And the high yield could have been more from a drop in the stock price than an increase in the dividend.

What Is Dividend Growth?

Another method is to invest in stocks with dividends that have been growing. Or you can invest in those that are expected to grow. You can use online stock screeners to find stocks of companies that have increased their dividends.

Just like a high dividend yield, a growing dividend payout isn't a sure sign a company will continue to pay dividends in the future. Reality Shares Advisors provides a DIVCON health rating for dividend-paying stocks. It estimates the probability that a dividend will grow or be cut within the next 12 months. The rating system is based on cash flow and earnings, among other factors.

The Balance does not provide tax, investment, or financial services or advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk, including the possible loss of principal.